U.S. Fed QE3: Why Bernanke's announcement is the real deal

The Federal Reserve launched another aggressive stimulus program on Thursday, saying it will buy US$40-billion of mortgage-related debt per month until the outlook for jobs improves substantially as long as inflation remains contained

Ben Bernanke and the U.S. Federal Reserve brought out the bazookas Thursday with the announcement of QE3 and all indications are that this is the real deal.

The Fed announced it will begin buying $40-billion in agency mortgage-backed securities every month starting Friday. It also extended its so-called “Operation Twist” program to the end of the year, whereby it sells its short-term bonds for longer-term bonds in an effort to drive down mortgage rates. Finally, the Fed extended its near-zero interest rate guidance until mid-2015.

All of this will bring the Fed’s monthly asset purchases to US$85-billion a month until the end of the year.

But the most important part of the announcement was that all of this is open-ended, meaning the Fed is committed to the new round of quantitative easing for as long as it takes. Even after the economy begins to recover. That is huge.

Related

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.

This is the first time the Fed has committed to keeping rates low even after the economy starts growing again. This will be a huge reassurance to businesses and c0nsumers who are staying away from big purchases, precisely because they’re afraid that a rate hike could make their loans unaffordable in the near future.

Also significant is the fact that the Fed has made it clear if things do not get better, it will go even bigger with its bond buying. Here is the key statement from the FOMC release today:

If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.

What’s also important here is that the Fed has come out clearly and said that all options are on the table. As Michael Gregory, senior economist of BMO Capital Markets points out, this represents a new approach for Bernanke and his team.

“The Fed has shifted to become more nimble and proactive, so expect many more policy manoeuvres in the future,” he said.

Stock markets are certainly liking this level of commitment. Before the Fed announcement at 12:30 p.m., the S&P/TSX Composite index was in negative territory. It is now up 125 points, to 12,358.02. The Dow Jones Industrial Average has surged to its highest level since Dec. 2007, gaining 225.71 points to 13,559.06.